Almost all of us make this budgeting mistake — here’s how we can avoid it

JillianBerman

Sarah Newcomb was 28 years old when she first realized her ease with numbers didn’t translate into a comfort with finances. She’d just completed her bachelor’s degree in math and money felt tight.

“No matter what I did, there was never enough,” said Newcomb, a behavioral economist for the investment research firm Morningstar. “I had to recognize that it had nothing to do with numbers, that there was something else going on with me.”

After completing a master’s degree in financial planning and a doctorate focused on economics and psychology, Newcomb realized that the story she was telling herself about money didn’t add up. “I hated money,” she said. “I was afraid that if I had too much it would corrupt me because I had been brought up with the whole ‘money is the root of all evil’ philosophy. I had to realize that I was actively sabotaging my own financial options.”

That epiphany helped Newcomb develop a budgeting strategy that focuses more on the human elements of making, spending and saving money. In her new book, “Loaded: Money Psychology and How to Get Ahead Without Leaving Your Values Behind,” Newcomb details that philosophy.

MarketWatch spoke with her about some of our biggest budgeting mistakes and the best ways to maximize our resources.

MarketWatch: What is the biggest mistake that people make when they’re setting budgets?

Sarah Newcomb: The biggest mistake we make is we focus on the numbers. That may seem counterintuitive, but the reason I say that is that the numbers are an important part of our financial plan, but they’re only a small part.

That cash-flow budget that we all learn [income in, expenses out] — it’s an important part of the story, but it’s not the end of the story. A cash-flow model of budgeting from a psychological standpoint is somewhat flawed. We feel as if money is something that we have to go out to get and then we struggle to keep in our lives. Rather than that, I think what we need to do is focus on the bigger picture, which is more of a personal economy.

If you don’t understand that your income comes from your assets — your resources that are being put to use creating value for your community or for your employer — then money is an external thing that you go out to get. Once you switch and you say, “No, wait a minute. Every line of income can trace back to my time, my intelligence my resources, my expertise” — when you think about your salary, your paycheck is your time. Your labor is valuable, so if you lose your job you haven’t lost your asset. You’ve lost a buyer, but you haven’t lost an asset.

The real problem with budgeting is that people tend to just slash expenses. If you’re only focused on that income and expenses column, then slashing expenses makes sense. But the reality is that every one of those expense line items traces back to a deeper human need. You can erase the expense, but you haven’t erased the need, and that’s why budgeting feels like a diet to people.

It is not a diet; it’s a map of how you’re going to take your personal resources to meet your human needs in a way that feels satisfying.

MW: What are some ways that people can still save money without cutting back on their needs?

Newcomb: A lot of people, when they trace their money for a certain amount of time, realize they’re spending hundreds of dollars a month on food and drink at restaurants. The need that they’re meeting there is probably not for food. It might be for social connection, in which case hosting a potluck can meet that same need without costing nearly as much money.

Or transportation. We all need transportation. We don’t all need a car and the seven to 10 expense line items that go with owning a car. You can find a way to meet your underlying need that costs less money. Often the need is not necessarily what we think it is. You always hear that you could save a gazillion dollars if you don’t go to a coffee shop in the afternoon, but your need is probably not for coffee. It might be for breaking up the monotony of your day.

MW: What are some of the common narratives about money that can get people in trouble?

Newcomb: The stories that we tell ourselves are super important. I’ve already mentioned the money-will-corrupt-you story, which is pretty prevalent. There are also just cultural stereotypes: The rich are greedy. Or the poor are lazy. Those kinds of little mental rules of thumb, they work really well with the way our brains organize the world, but if they’re based on simplistic stereotypes they can interfere with a lot of things.

One of the biggest reasons we are so underprepared for retirement is the way that we think about time. It has nothing to do with our social conditioning; it’s simply the way that when we think about today versus tomorrow — our minds shrink the importance of the future because of the way we mentally think about it.

There is some encouraging work out there on how to counter those effects. We can hack our brains in a sense, do little visualization exercises that put a lot of clarity and detail into your mental picture of the future. Even age progressing your face [can help].

[The narratives are] not that complex, but you have to understand them so that then you can counter it.

MW: When people are sitting down to make their budget, what are some of the key things they should do?

Newcomb: It’s really simple. Know where your money is going — so you have to track it — and then you have to spend less than you earn and invest the rest. That is money management. If it was really that simple, we’d all be doing it.

You have to be honest with yourself about where your money has gone. We really need to start to think about how money moves in our lives, give it the same kind of thoughtfulness that we give other areas in our lives. If we only think about it in terms of numbers, we think that it’s supposed to be this logical mathematical exercise, and we treat it that way. But when you sit down and you think about your life, how are you organizing your life so that your needs today feel satisfied and you’re not sabotaging your needs for the future?

MW: With wage growth still relatively sluggish, particularly for young people, many are using so-called side hustles to earn some extra money. What are some surprising ways people can bring more money in?

Newcomb: If you live in an urban area and if you own a car, rather than just paying to have that car parked all the time you can put it into a car-share program where other people pay you to drive it during the day while you’re at work. That’s just one way to take a current resource and turn it into an income stream.

A lot of us have talents that go unused, unshared. You play an instrument? You could be teaching one lesson a month. We also tend to think that if it’s not a large stream of income, then why bother? But a little bit goes a long way. We spend our money little by little and it adds up, and we can do the same with our income. You can be making $25 to $50 a month selling stuff from your basement that is going to waste — little things like that.

Sallie Krawcheck [the Wall Street veteran who is now chief executive of Ellevest, a digital financial advisory firm geared toward women] said something last summer that really struck me when it came to women and financial advice for women. She said financial advisers would do so much better by their female clients by advising them to ask for a raise and close the gender pay gap than to just fiddle with their portfolio a little bit and try to get them an extra percent. They’re going to get so much closer to retirement readiness if they can close that wage gap. Recognize the value you have and what its value on the market really is.

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